If you’re going beyond index funds, don’t just throw darts
I am a firm believer that index funds should be the primary investing strategy for 99% of the general public. The upside relative to the risk (and cost) simply require patience with very little investing expertise to amass a sizable amount of wealth. My most successful Medium post thus far was my perspective on exactly why I think even highly financially literate people should avoid buying individual stocks.
However…
I want to highlight that one’s primary investing strategy doesn’t necessarily have to be his or her only investing strategy. For those fortunate enough to have already built a solid financial foundation through index fund investing, carving out a portion of their portfolio for well informed bets on the future can be a viable way to increase upside within their risk tolerance.
A notable lesson in history comes from the California Gold Rush in the mid-nineteenth century. With the news of gold bringing approximately 300,000 people to the state in search of riches, a few struck gold (quite literally) but the vast majority of them wound up empty handed. The most reliable and consistent revenue stream flowed not to the gold miners, but to those providing the picks and shovels to them.
The lesson is that IF you want to invest in something more targeted than the broad markets, invest in the underlying technology needed to produce a good or service rather than investing in the final output. This will greatly limit risk while maintaining significant upside.
Here are a few examples putting this decision logic in practice…
**As a disclaimer, I am not recommending specific companies to invest in, but rather the thought process that can go into investing in specific companies for their long term outlook. This does not factor in a company’s valuation. Experienced investors will factor in whether an investment is in the right company AT THE RIGHT PRICE — these examples are simply taking into account whether it is the right company.
Example 1 — Buying into the metaverse
This first example is a somewhat nebulous term that describes a very hot trend. Early visions of the metaverse have typically been portrayed as immersive experiences of VR and AR, featuring avatars of our “digital selves” with an expectation that digital products, services, and experiences will one day carry similar value to their counterparts in the physical world. How this actually materializes is unknown, though our imaginations typically conjure up images of the movie Ready Player One as a conceivable iteration.
The possibilities are limitless in this natural evolution of the Internet. So where does that present an opportunity as an investor?
The “picks and shovels” mentality would skew us away from companies developing specific experiences in the metaverse, and instead toward the companies enabling those experiences to be created in the first place. This may include 3D visualization engines, chip providers, or artificial intelligence platforms. Consider the market leaders in these spaces if you are interested in owning a piece of this mega-trend for the long haul.
Example 2 — The rise of autonomous transportation
Autonomous driving is undoubtedly on the mass market horizon, with car manufacturers and technology providers racing to win the space. Arguably the most popular investment in this domain is Tesla (TSLA). While I am not speculating on whether Tesla is a good or bad investment, it has certainly become the “face” of innovation in this space for many investors.
The picks and shovels logic would suggest investing in the “brains” of autonomous driving rather than any particular car manufacturer. If a company like Tesla has its own proprietary brains to power autonomous driving for its own cars, it may be very successful in doing so but it constrains the market potential for that technology to just Tesla.
If you truly believe in autonomous driving creating a sweeping change to transportation around the world, a lower risk strategy may be to invest in the AI or other technology platforms specializing in autonomous driving rather than the car manufacturers themselves. There are many players in this space, and some already have partnerships with several car manufacturers. This can potentially insulate an investor from extreme risk while continuing to participate in an exciting and long lasting trend.
Example 3 — Climate change and energy efficiency
Energy efficiency is perhaps the most certain of these three trends here simply because it is the most necessary. It is arguably a requirement for a sustainable future rather than a luxury or yet another source of entertainment. While most indications from both the public and private sectors are that electricity is the future, the specific mechanisms and sources for leveraging electricity seem to be unknown, with solar, wind, nuclear, and hydro energy among those heavily debated for their pros and cons.
A rising tide lifts all boats, but where is the tide as it relates to a growing shift to electricity if we don’t even know what types of electricity will gain prominence?
One thought is that electricity transmission and distribution provide a more certain pathway to the electricity trend, almost in the way that railroads did for transportation. This can potentially address many of the electricity utilization issues that raise concerns today, while providing a hedge to investor risk.
Another idea is that clean energy is always going to require the equipment to generate it. This equipment will require various natural metals such lithium and cobalt, with a potential opportunity for the leading companies who mine or preserve these metals. In any case, this offers at least some protection for an investor’s downside in the event that the specific sources or providers of electricity are not what we expect or that they change over time.
Closing thoughts
Investing in specific companies is not necessarily a bad thing. However, if you are not a professional investor who does thorough business and financial research on individual firms, it may stretch you beyond a risk profile that you are comfortable with.
Typically, the recommended strategy for the non-professional investor is to buy low cost index funds tracking the broader markets, which has undeniably proven results compared to trying to beat the market. However, if you want something in between these two strategies and have your financial house in order to the point where you can take a few calculated risks, there are ways to do so.
If you believe wholeheartedly in a particular trend, take the time to study exactly what underlying innovation will enable that trend to unfold and who is best suited to execute on that innovation. Most importantly, have the patience to see it through.
This article is for informational purposes only. It should not be considered Financial or Legal Advice. Consult a financial professional before making any major financial decisions.
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